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"Show Me the Money: Raising Capital in a Challenging Market"

Banking Alert

2009

Across the country, banks are facing severe economic challenges from both external market forces and increased regulatory requirements. Experts anticipate that during the remainder of 2009, banks will continue to experience credit losses in their loan portfolios while also incurring unprecedented expenses to fund the FDIC. Bank regulators are also requiring banks to increase their capital levels in a market where the traditional methods of obtaining capital, such as trust preferred securities, are unavailable. Even West Virginia banks, whose conservative business practices and traditionally strong capital positions have helped them weather the storm so far, may find it desirable to raise additional funds as the economic crisis deepens. There are a variety of methods banks can use to obtain capital in a difficult market.

Private Placement or Debt Equity Securities Most West Virginia banks are not publicly traded. For these banks, the most viable option for raising capital will likely be engaging in a private placement of equity or debt securities, usually through the sale of preferred stock or subordinated debt. A private placement typically involves the sale of securities to sophisticated, “accredited” investors and a limited number of unsophisticated investors. There are several benefits to raising capital through a private placement. Among other things, a private placement usually requires less disclosure and less time to complete than a public offering. In addition, potential securities law liability is more circumscribed in a private placement than in a public offering. On the negative side, shares or debt securities issued in a private placement will be subject to resale and transfer restriction.

Many banks choose to issue subordinated debt because it is one of the quickest ways to raise capital. Subordinated debt issued by banks is a debt obligation that contains both debt and equity characteristics. It has the tax advantage characteristics of debt, but is treated as equity if certain regulatory criteria are satisfied. Typically, the bank holding company will issue subordinated debt and inject the proceeds of the offering into its subsidiary bank. A portion of the subordinated debt will qualify as Tier 2 capital at the holding company level if the criteria are met, and the cash proceeds from the subordinated debt injected into the bank will qualify as Tier 1 capital.

Another alternative is to issue preferred stock. Many companies considering this alternative should check their Articles of Incorporation to be sure this class of stock has been authorized by the company’s stockholders. If you believe your bank may want to raise capital in the near future and it does not currently have preferred stock available for issuance, you should consider seeking shareholder approval to authorize the issuance of preferred stock at the next annual meeting, or calling a special meeting for this purpose.

Other Methods of Raising Capital In lieu of a private placement, banks and holding companies that are publicly traded may want to consider filing a shelf registration statement with the SEC. A shelf registration allows multiple offerings of securities based on the same registration. An effective shelf registration statement permits an issuer to access the capital markets quickly when needed or when the market conditions are optimal and provides a public company with maximum flexibility to offer and sell various kinds of equity, debt or hybrid securities.

There are also other options that involve less conventional ways of raising capital (some of which include the use of an effective shelf-registration), and these should also be considered by publicly traded companies in this difficult market. Like the shelf registration process, these methods also require that an issuer meet specific eligibility requirements. These alternative methods include a private investment in public equity (PIPEs); a registered direct offering, and an at- the- market offering (ATM).

In the current market, a bank should explore each financing alternative in light of the regulatory requirements and marketing restrictions applicable to each method. A bank should select the most appropriate method of financing based on its specific business needs, legal considerations, eligibility limitations and the current market conditions.

A version of this information was published in the Fall 2009 issue of WV Banker Magazine.